What is debt 'consolidation'?

The idea of consolidating debt is a pretty simple one, and has been around for a long time. In essence, the idea is that you take a number of debts - for instance credit card balances and loans - and pay them off by moving them to a single, cheaper debt. The theory is that, by consolidating, you end up paying less each month, thereby taking some pressure off those monthly household finances.

Is consolidating a good idea?

There is no single answer to this question, since a lot depends on your circumstances - in particular how much debt you have, from how many sources and what level of interest you pay on it. For instance, if you have a lot of credit card debt, consolidation may well be a good idea, since credit cards are often the most expensive way to borrow money. The reality, however, is that the vast majority of people who use consolidation to pay off credit card debts go on to run up debt again - ending up with both the original 'consolidated debt' and a new credit card debt.

In simple terms, consolidating debts is not the easy option it seems as there are lots of potential pitfalls that need to be considered as well as the short term benefits.

It is useful as a last resort if you are really struggling to meet a variety of monthly payments - however, once you have taken this step, you must be very disciplined about falling into debt again.

Can I use my mortgage to consolidate debts?

In theory, yes you can. However, there are lot of considerations to weigh up before you take this step - some of which will help you decide if it is a good idea, and some of which will determine if it is even possible.

Can I do it?

Before you think any further about using your mortgage to consolidate debts, it is worth thinking about whether it is going to be possible. Here are some of the key areas to consider:

  • Do you have enough equity in your property to enable you to borrow more money against it? Remember that when you borrow more against your mortgage, you are actually borrowing against the value of your property. If your mortgage is already around or above 80% of the value of your home, borrowing more money is likely to be very difficult, or at least expensive.

  • Does your mortgage deal allow you to borrow more and are there any costs involved? Check the terms and conditions of your mortgage to see if additional borrowing is allowed. If it is, check what costs are likely you be involved (fees etc). Remember that any fees or administrative costs are likely to be added to the loan, effectively making your debt that much higher.

  • Would you be forced to 'remortgage'? If you would need to find a new mortgage deal in order to borrow more then there are likely to be costs involved. For instance, getting out of an existing deal is likely to incur early repayment charges - again, these can usually be added to the new loan, but this means your debt will be higher and overall more expensive.

  • How much would it cost you? If you are serious about considering this course of action, it is a good idea to contact your mortgage lender to find out how much you can borrow and at what cost. The answer they give you will help you decide if it is a good idea to roll other debts up with your mortgage.

Is it a good idea?

Well, as with most financial decisions, there are upsides and downsides, but no hard and fast answers - everything depends on your situation. The trick here is to balance the potential benefits with the risks.

Take the benefits first:

There is not a lot to say here, except that your monthly payments will certainly be lower. That is, because mortgages are typically repaid over a long period, the portion of the monthly payments linked to your consolidated debts are likely to be much lower than they were before.

For instance, monthly payments on a personal loan totalling 10,000 and at an interest rate of 8% over two years is likely to be in the region of 450 per month. The same debt, paid through a 20 year mortgage, with an average interest rate of 6% would cost around 70 a month.

In essence, the benefits associated with this kind of consolidation are short term - you will be better off each month compared with paying off a loan or credit card. However this is certainly not true over the long term, and there are significant risks to be aware of.

But seriously consider the risks and downsides:

Putting your home at risk: It is always a bad idea to convert unsecured debt to secured debt, since this puts your home in the firing line should things go wrong. This should always be a route of absolute last resort.

The overall costs are likely to be much, much higher. That is, you may well pay a less each month but, since mortgages are long term debts, you are likely to end up paying a lot more interest than you would on a short term debt product.

Taking the example above, the two year 8% loan would cost a total of 800 in interest, whilst you would pay around 7,000 in interest on the 20-year, 6% mortgage. This means that overall, whilst your monthly payments would be lower, you'd be 6000 out of pocket

The debt will last a lot longer. If you pay off existing debts by adding them to your mortgage, they will stay with you for the life of the mortgage (say 20 years), when most unsecured debts can be paid off far sooner, if you have the money available to make the payments each month.

Remember that, throughout that 20 year period, you home will be at risk if you fail to keep up the repayments on the mortgage.

In summary:

  • Using your mortgage to consolidate short term, unsecured debt is rarely a good idea.

  • If you can make the payments required to bring down the balance on your unsecured debts (i.e. credit cards, loans, finance agreements) you should consider it, and make overpayments if you can afford to (check the provider's terms and conditions first). It may be painful in the short term, but this is ultimately the best way to get rid of these debts.

  • NOTE - In the case of credit cards, the minimum payment is not enough. To clear the balance you must pay back enough each month to cover any interest added AND pay back some of the outstanding balance.

  • If you debt is on credit cards, consider transferring the balance to a credit card with an interest free introductory offer or a low rate lifetime guarantee on balance transfers. This will help to reduce interest payments and give you a better chance to pay off the debt. However, if you do this, you must be disciplined about getting the balance down by making payments each month and refraining from building up extra debt elsewhere.

  • Do not use 'mortgage consolidation' simply to free up spending money' It might be nice in the short term, but you will pay for it in the end, in spades.

  • If you are having trouble making payments on credit card and loan debts, talk to your provider before resorting to extending your mortgage. It may be possible to agree a payment schedule that will enable you to gradually bring down the debt in an affordable way, without spreading it over 20 years or so.

  • Only consider using your mortgage to consolidate debts as an absolute last resort - it is expensive, long term and high risk debt (you could lose your home of you fail to make the required monthly payments)

  • Even then, you will need to talk to your mortgage lender to see whether it is possible for you to borrow more, and what the costs are likely to be.